Mutual funds are taced at long term capital gains rate right? Wrong. There seems to be some confusion to how mutual funds are taxed. What you need to know is there are distributions on mutual funds that are taxable. These are called annual distributions and are made in late November and early December. These distributions, if the fund has any gains, are taxed at either ordinary income or long term capital gains tax.

This is where the anti-annuity crowd usually steps in and says mutual fund tax treatment is so much better than variable annuities, is this true? It is not. You have 3 taxes with mutual funds, the short term distributions (distributed usually every year), long term capital gains (distributed usually every year) and then when you sell the fund you will have another long term capital gain (I am assuming you made money with the fund). I did not mention dividend tax because not all funds have dividends, that would make 4 taxes on mutual funds.

With portfolio turnover rates at about 75% we are finding that the distributions are becoming more short term than long term. This means higher taxes on these distributions. These distributions can continue even if the mutual fund goes down. This happens because mutual funds tend to capture profits quickly in today's market. They like to realize the gain rather than risk losing it. This is why the turnover rate in mutual funds are so high.

Mutual funds are a little more skittish because of the market losses in 2000 through 2002. Ever since those time periods we have seen the turnover rate climb, again because most funds want gains not loses. Also, when mutual fund investors sell their funds this generates activity and the fund manager may have to sell positions in the fund to cover the sale amount. This could generate more distributions.

When I examined how long mutual fund investors hold their funds for it is fairly interesting. The average no-load investor holds on to their fund for about 3 months. A loaded, or broker sold, mutual fund investor holds their funds for about 3 to 5 years. The longer the holding period the better it is for you. Lower turnover means, potentially, lower short term capital gains.

The disturbing part about mutual fund distributions is when the market plummeted in 2000 to 2002 short term distribution rates went way up. Basically, you lost money in the market and

My point to all of this is taxes on mutual fund are not 15% long term capital gains like everyone says it is. When we add up all the taxes you pay it can be as much as ordinary income. So why pay them now when you can defer them? It makes sense to me. When you wrap up a living benefit that guarantees you your money back, I find the argument against variable annuities diminishes.

It would be easy for me to go along with the crowd and talk bad about annuities or distort the truth, but the facts are the facts. Taxes on mutual funds are just as bad as or worse than variable annuities. Plus, with annuities you have those living benefits to guarantee your money back, in some form or another. Yes, there is a fee for a variable annuity, but given the fact that you can get a guarantee on your money it is worth it. Also, given the taxes you have on mutual funds the variable annuity is still cheaper.

Granted I am not talking about index funds, but most people do not own index funds anyhow. The fact is these taxes are very real and whether you pay them out of pocket or out of your investment you have to pay them. That money, I am sure, is better off in your pocket than Uncle Sam's pocket.

Avariable annuity is not right for everyone. Getting the right information is so important. If you are going to buy a variable annuity do your research first, www.annuityiq.com is a great place to start.